Commentary: Looking For Growth In All The Wrong Places

Many advocates of privatizing Social Security have bigger ideas in mind than just fixing the system's financing. Their goal is to force households to save more for retirement and thus raise the personal-savings rate, which has fallen to around 5% from 8% in the 1970s. They argue that juicing up savings would make the U.S. a richer nation in the 21st century--and make the burden of an aging population more tolerable. Act now, says Boston University economist Laurence J. Kotlikoff; "The longer you wait, the deeper the hole you dig."

But it's not clear that stronger economic growth would result from the reforms that are being proposed--namely, raising payroll taxes, diverting some of them into the stock market, and setting up individual retirement accounts much like 401(k) plans. Most workers who want to keep spending will be able to defeat efforts to make them save more through Social Security. They'll do it by reducing other forms of saving or by borrowing more. What's more, even if the government could force the personal-savings rate upward, some economists question whether it would truly make the economy grow faster.

A WASH. Start with the proposal to invest payroll taxes in stocks. Wall Street loves the idea. By itself, though, the move would do nothing to create a new pool of savings. It would simply siphon away money that currently goes into government securities. To keep operating, the federal government would have to borrow more on the open market. For the economy as a whole, that's a wash. No wonder that even at Wall Street mainstay Goldman, Sachs & Co. economists headlined their analysis "No Free Lunch."

Most savings advocates on the Advisory Council on Social Security acknowledged as much in their recent report. That's why council members such as Carolyn L. Weaver of the American Enterprise Institute put such weight on boosting the payroll tax and funneling part of it into private savings accounts.

But those steps might not boost savings either. After all, the vast increase in savings under 401(k) plans since the mid-1980s hasn't budged the personal-savings rate. Brookings Institution Senior Fellow William Gale points out that the net amount of private savings in the U.S. is actually less than the amount in tax-sheltered savings such as 401(k)s. The reason, says Henry J. Aaron, another senior fellow at Brookings: "People have collectively undone the effects of these savings incentives by other dissaving," such as credit-card borrowing, home-equity loans, and reduction of other saving.

Raising payroll taxes might extract more money from middle- and lower-income Americans, but it would cause real pain. Many of these people can't offset an increased tax by decreasing savings elsewhere--because they aren't saving anywhere else. And they've already borrowed to the hilt. It hardly makes sense to target a savings campaign at the bottom 60% of households, which account for just 28% of national income.

BUDGET MYTH? In any case, the benefits of forced savings might not be worth the pain. Last spring, the nonpartisan Congressional Budget Office considered the effectiveness of a different means of increasing national savings--that is, cutting the federal budget deficit. The CBO analyzed two scenarios: a federal budget in balance from now through 2030, vs. one in which federal debt rises as rapidly as gross domestic product. It concluded that real GNP per capita in 2030 would be just 2% lower under the rising-debt scenario than with a balanced budget.

Some contrarian economists argue that forcing up savings is likely to slow the economy, depressing investment rather than sparking it. "You need to stimulate the investment decision," says University of Texas economist James K. Galbraith, a Keynesian. He would rather stimulate growth by cutting interest rates. Incomes would rise faster than consumption, and the widening differential between the two would be the savings that fund new investment.

Critics notwithstanding, Social Security doesn't need an increase in payroll taxes anytime soon. Make a few fixes, such as lowering the too-high cost-of-living adjustment, taxing benefits more, and speeding up the transition to a later retirement age, and you have a 75-year fix that

doesn't require a payroll-tax hike for decades to come.

Raising the economy's growth rate is the single best thing this generation could do for those to follow. But it's a mistake to put that responsibility on the back of Social Security.

Before it's here, it's on the Bloomberg Terminal.